Moody's Corporation (MCO) Earnings Call Transcript & Summary

Hello again, and welcome again to the UBS Financials Conference, which is virtual today. I'm Alex Kramm, senior research Analyst at UBS, covering the U.S. exchanges, rating agencies, information services companies and then commercial real estate brokers. With us today or next up, I should say, is Moody's. I don't think it needs much explaining. Obviously, 1 of the 2 large rating agencies globally, but they also have a few other things. I think we'll hit on both, although the focus will likely be much more on the rating agency today since we have Michael West here, who's been, I guess, somewhat newly minted president of that group to run us through. This will be a formal presentation for about 20 minutes or so, and then we'll jump into Q&A. There is an opportunity for you to submit questions. I'm happy to ask them, so don't be shy and submit your questions, and we'll go from there. So with that being said, Michael, why don't you take us through Moody's and the rating agency and a few other things you want to talk about?

Great. Thank you, Alex, and thank you to everyone for joining. And as Alex explained, I've become the President most recently, but I've been with the company for over 20 years. So if I could just jump into the presentation here on Slide 3, just want to level set with everyone. For those that are unfamiliar with the company structure is that Moody's Corporation is a global, integrated, risk assessment firm made up of 2 businesses: firstly, Moody's Investors Service, which we'll refer to as MIS during this presentation; and then there's Moody's Analytics that we refer to as MA. MIS is the independent provider of credit rating opinions and related information into the markets; and our sister company, MA, provides financial intelligence and analytical tools to support customers' growth, efficiency and overall risk management objective. So just wanted to ensure that people have that level setting before I jump in to Slide 4. And as Slide 4, as President of MIS, my goal is to ensure that Moody's is the thought leader and agency of choice for our customers. And core to our strategy is a recognition that both issuers and investors actually do have a choice of providers, and we want to ensure that Moody's is top of mind when it matters to both parties by reinforcing the connection between the issuers of debt that request our ratings and the investors who demand our services. And that's a key component to keep in mind as I go through this presentation because the core components of agency of choice are really, first and foremost, ratings quality. MIS has proven ratings accuracy and deeply experienced analysts. And this comes from decades of unyielding attention to that ratings quality, which is a differentiator and particularly at times like this when we're going through periods of stress. Then there's the provision of research and insight through our written research and data that must be constantly insightful, timely and relevant to users, and importantly, needs to be available in formats that are oriented to meet the new dynamics in the market and how people want to consume. And then third, there's engagement and service. And we need to touch our customers and our constituents through our analytical work but also our commercial engagement and make sure that Moody's is part of the market fabric, ensuring that people in the market make good and better decisions. And then finally, our overall value proposition and making sure that our sales and marketing teams continue with that value proposition as the world's most authoritative source on credit and Moody's bringing efficiency to the overall market. So let me just jump on to Slide 5. Slide 5 really focuses on what we're going through at the moment, and I wanted to spend a few minutes just talking about maintaining agency of choice status becomes ever more important during turbulent times like this. And our ratings are ever so more important to investors and provide that opinion through this cycle. Important here is transparency and relevancy of how we actually make our decisions, not just by asset class or jurisdiction, but across the globe to ensure that investors that use this service have an appreciation. And as head of the organization, we have to ensure that when taking all these rating actions that our approaches and our methodologies and communications are fully transparent and that we are engaging with the market. And when we think about linking back to our goal by ensuring that we want to get the ratings right on the bottom right-hand side here shows that link to defaults and the ordinal ranking. And we have to demonstrate that there is a good ordinal ranking that demonstrates that we get the rating right, not from a transition, but also at the point of default. And those measurements are actually 1 year prior to default. So jumping on to Slide 6. The strength and quality of our ratings is reflected in the strong results we've shown in the second quarter and indeed over the first half of the year. The main driver of this growth is a 47% increase in revenue from our CFG line of business, which saw issuers opportunistically coming to the market in order to bolster the liquidity. But issuance was also strong in the FIG sector and the public and infrastructure sectors, resulting in overall increase in issuance that Moody's rated of approximately 53% year-over-year. One of the asset classes that saw decline was actually structured finance, and we continue to expect that to be the weakest of all our segments, primarily due to lower asset generation. Importantly, we outlined this both in the first quarter, and importantly, on the second quarter about the dichotomy here between the functioning of the debt capital markets compared to that of the real economy, and that's been helped by the monetary policies by the Fed and other central banks and authorities around the world. So going on to Slide 7, this really talks about the mix of issuance. And for those that are not familiar with our fee constructs, MIS offers different pricing programs depending on the customer issuance needs. And generally speaking, infrequent issuers would pay a higher transaction fee with the recurring annual fee being a smaller element of their overall fees. Conversely, if you are a frequent issuer, they would pay a lower transactional fee with recurring annual fee being a larger element of the overall package. That means that it's not just about volumes that matter to our revenue growth, but it's the mix of that issuance. And the recurring revenue is a very important element of our business because as each mandate comes in and enters the total stock, we are building that recurring revenue over time. And this then feeds into the overall financial profile that we've outlined on Slide 8. And you can see from the bar chart that this has led to a recurring revenue becoming about 34% of MIS' trailing 12-month revenue as at 30th of June, and this provides this core stability and ballast for the MIS revenues, and that grow modestly year-over-year. The pie chart provides additional color on how recurring revenue can actually vary by different lines of business. For example, the banks tend to have a higher proportion of recurring revenue. You can see that 52% as they're generally the most frequent issuers as it comes to accessing the capital markets, whereas corporate finance, which is our largest line of business, responsible for 56% of the $3.2 billion of trailing 12-month revenue, is more transaction-focused. And again, we have to keep that in our minds when we think about the business model that we have. Slide 9 really talks about those drivers of issuance in the first half, and I touched on issuance a little earlier and how liquidity and the need of many issuers to come to the market to fortify their own balance sheets and provide ample liquidity to see them through the current environment, ratioed on the earnings call that the liquidity here for investment grade was about working capital and building those. You see also that being very similar in the high-yield space, and it's this diagram that focus on the high yield, where there's been a growth in liquidity for working capital and liquidity and also on the balance sheet to potentially prepare for any refinancing needs given uncertainty that can prevail at times like this in the market. We often get many questions about the pull forward of the overall debt stack. If you turn to Slide 10, the answer to that question of whether we've seen that pull forward, I think, is rather nuanced. And what we've talked about on our earnings call is what we call contingent pull forward. And the way we're looking at that is that companies have borrowed in the market, they are keeping excess liquidity, fortifying that -- their balance sheet to see them through. It's still important to look at those refinancing walls, and we will be updating those later on in the year. And -- but corporates and treasurers, in particular, are seeking to navigate these markets and may indeed tap the market more than once during this period to ensure that they have adequate liquidity to see them through free cash flow losses or just to ensure that they can keep with their capital commitments. Slide 11 really jumps to talk about that longer-term trend. So moving away from this current market sentiment and the need to build liquidity but starts to talk about the underpinnings of our overall external environment, and that is one of disintermediation and the shift away over time from loans into the capital markets. Obviously, Moody's rates both loans and bonds. But you can see every quarter that the data has remained relatively consistent with EMEA growing a little slower towards more bond, while the U.S. maintains a 50-50 ratio. And we don't see COVID causing a significant shift or structural change in this dynamic. And from a top line perspective, I want to outline that this is a key contributor, not in just -- in mature markets, but also in emerging markets. And just to spotlight a little bit, just on Slide 12, people often talk about the growth in debt in the system and leverage. This portrays, over time, both European and U.S. that companies have increasingly been managing, too, interest rate coverage. And you can see that there's been a modest uptick in overall leverage in that system. There may be some movements towards the second half as we see weakness in cash flows that may, again, see that increase in debt to EBITDA. But when we think about overall what is driving our business, that's what I'd like to talk about on Slide 13. And really, the outlook does consider some of those challenges and headwinds that we expect for the remainder of the year and the likely activity that we've put out there into the market. There is an expectation of increased defaults. We published a couple of days ago our most recent default study that showed an uptick in July compared to June and May, and the second half is expected to be impacted by an assumed slowdown as well as challenging comparatives. Last year and the second half was particularly strong, and that makes it difficult on a comparative basis when you're looking at overall growth. And we're not expecting Q4 to ratchet up meaningfully after summer given the focus on elections and also a potential wave, a new wave of COVID outbreaks and the likelihood that many issuers have already sought funding in the first half. So really, it's a normalization of issuance going into the second quarter. Talked a lot about issuance on the top line. I want to just draw a little bit of attention to Slide 14, which is the cost side and delivering into the market. And when I focus on this diagram, you see the focus on technologies to help lower our costs, improve our efficiencies, Six Sigma design thinking that can bring speed to market, interactivity and a digitization of our product. It allows us to think differently about our staffing model, about the utilization of lower-cost centers of excellence, like we now have an IT incubator on tech hub, not only in New York, but Charlotte and in India. And it also allows us to think differently about our different markets, how we address our markets and new opportunities. So I'd like to flip to 15, which brings a lot of this together. I mean this is what Moody's Investors Services is in one slide. And this really outlines the agency of choice where we are rating over $70 trillion of debt, over 36,000 rated companies and structures. And not only did we publish 40,000 reports in '19, but we're ahead of the curve when it came to thinking about concerns in the market and late cycle issues, and we talk a little bit about that when it comes to CLOs and the impact on CLOs. But no presentation wouldn't be complete without a quick mention of China and ESG. So just to reset, Moody's approach to China is twofold. We own a 30% stake in CCXI, which is licensed CRA in both the interbank and exchange-traded markets in domestic China. And we're very pleased with CCXI's performance. It maintains a leadership position in that market with over 1,700 rated customers and around about 40% issuance coverage as of last year. As we all know, China is taking some important steps to open up its financial markets to the global credit rating agencies, and we are also enshrined in the U.S.-China Phase 1 agreement. So we continue to evaluate our options in the short term. But really, our eyes very much on the long term. And as I mentioned, we are very pleased with CCXI, and no other international CRA has such an arrangement. When we think about the overall revenue picture for China, you can see $176 million revenues already coming from Greater China split here between Moody's Analytics and MIS, and then that's not counting the $17 million attribution -- attributable income that we actually get from CCXI. Currently, we are also focused, as you know, on the cross-border that is distinct from the domestic. And we have over 400 global credit ratings in Mainland China and Hong Kong. And despite some noise around the current environment leading up to the election, our view is a long-term view. We've been in China since 2001. We've had the stake in CCXI since 2006, and we feel very comfortable in moving forward. So if I just jump very quickly to ESG and really thinking about ESG and climate, and it's important that we consider this in 3 areas. One, there is embedding ESG considerations into the ratings and looking at how those considerations impact the ratings and the transition of the ratings over time, whether that be carbon, whether that be climate, and ensuring that we are transparent, we are speaking to the market and the debt investors and giving a clear view on credit quality and credit transition. And as you know, there's more money flowing into these funds. There was an article earlier this week in the FT that talked about that funds between April and July this year focused on ESG actually exceeded that of the full year '19 and the years prior to that. So that's the credit side. We've got Vigeo Eiris and Four Twenty Seven, our ESG businesses. They have direct sales channels into customers. We use their data. They are also providing data into the index businesses of other firms, and that's where we feel very good about those positions of those 2 businesses, and they're also supplying data over to Moody's Analytics to power some of those products focused on CRE, stress testing, et cetera. Both the Vigeo Eiris business and Four Twenty Seven have great experience the over 20 -- over 30 years, and Four Twenty Seven has a very sophisticated approach that can take analysis of climate down to the property level. These are all very good examples how we at overall Moody's Corporation demonstrate our rigor, our thoughtfulness and relevance into the market, and ultimately, to be a standard setter in the ESG market. So Alex, I'll stop there and happy to take any questions. I've also got Shivani Kak, Head of Investor Relations, joining me to answer any questions that we get. So thank you.

Thanks, Michael, for the presentation. As a reminder, there is a chat to all or to ask questions, so please fire away, and I'll work them into the conversation. Maybe just to start a little bit bigger picture. You obviously laid out the growth algorithm of the business. But maybe you can just talk a little bit more about where you're seeing opportunities to still expand organically the business -- actually organically or inorganically the business, and this is both in terms of new geographies, emerging markets, for example. You talked about China already. I have a question on China later. But you did a little bit of an investment in Malaysia yesterday. And then outside of just geographies, are there any sort of asset classes where you see yourself underpenetrated, underrepresented that we should be thinking about when we think about Moody's opportunities?

Yes. Thanks for that, Alex. And again, I think it's important to refer back to the overall comments I made about the disintermediation trend and the overall capture. There's good organic growth. We feel we have the appropriate presence in developed and developing markets for our cross-border business and the relevance and experience of our analysts. In the emerging and domestic markets, we have a number of approaches, both through our affiliates, whether they be majority or minority owned. And we participate there in a number of the largest domestic markets that continue to expand in terms of debt issuance, and in that case, disintermediation. You mentioned the acquisition of a minority interest. I think Mark yesterday that talked about the importance of the sukuk market. The sukuk market in Malaysia, which is the largest Islamic finance market, continues to grow well. And we believe working with Mark and our own expertise in the -- in that particular area bodes well for both of us as well as the overall market development. So I feel comfortable where we are and the geographies that we play in.

Great. Maybe shifting gears then, I'll come back to China later. But obviously, people are obsessed with the issuance outlook. And like your guidance, you just obviously laid your guidance out again. Thanks for that. And you said yourself, there are some tough comps. Clearly, there's a little bit of a slowdown that people should be bracing themselves for. But where could we be wrong? Or where could we break to the upside? You said there's going to be the election later. But to what degree do you see maybe companies want to get stuff done before the election? So anyways, not to lead the witness here, but what are the areas that you're looking at or the things that you may be seeing already where things could actually remain a little bit stronger than maybe what we saw in July here recently?

Yes. I mean I think what we did on the second quarter earnings that we outlined our revised guidance in the key areas like high yield now up 5%; investment grade, up 50% year-over-year; and -- but still bank loans down 20%, structured down 40%. What we've kept our eye on here is that we believe there's some room on the runway for non-U.S. issuers to come to market. Many of our issuers in the first half came from the U.S. We still believe there's a good runway also in the U.S. for others to still come. But what we're outlining here with that forecast that it's a more normalized issuance rate in the second half compared to that desire and need to get the liquidity and the buffers in place, which drove a lot of that issuance. There's also the fallen angels, and we continue to watch conditions and the spreads related to fallen angels. And then there's M&A. M&A has been down 50% year-to-date, and the pipeline obviously remains somewhat light. But there are potential deals in what we would turn distressed M&A, where some of the industrial players or private equity may want to pick up some of -- some decent assets, so we may see some of that distressed M&A coming through, which, again, would bolster some of that issuance.

Some of the things that you're seeing the most, well, negative trends that, I mean, it's, yes -- it is a reflection of what it is, clearly in bank loans and in structured. Can you talk about those 2 areas? And you can pack them one by one, obviously. On the structured side, anything that may change the picture there, in particular? And then on the bank loan side, I don't know if it's just about yields potentially or interest rates potentially moving higher again and we're seeing flows into those products to revitalize. But what are you thinking about to -- for those 2 areas, in particular, have been areas of weakness?

Yes. In terms of the leverage loan market, a couple of things to mention there. First of all, a good number of the leveraged loan issuers were rated out of the box at the lower end of the rating scale. There's obviously concern at the lower end of the rating scale about the overall credit quality, the prospect of default should there be further weakness in the economy and the ability to actually get the financing in place. So there's a nervousness there with the investors. There's also a preference for fixed rate. And therefore, when you think about that lack of supply, then that actually flows into the CLO business. The CLO business needs assets to put together. And then at the same time, the structure needs to work from the arbitrage to make sure that there is adequate returns through the stack to the fixed income investor that's relying on the underlying asset servicing those cash flows. That has to work. And in cases where there's dislocation in the market, and it doesn't work, you do not get that formation and hence what we're seeing in the CLO market. Similarly, in the other area, the CMBS market concerned -- concerns around commercial property and the overall credit profile are again impacting supply.

Okay. One last one here because on the fixed side -- and I mean, last one on the issuance environment. On the financial side, you -- one of the earlier slides, you showed how that business is the most recurring. But I think at the same time, the transaction side of the business has been very good in this environment, too. So can you just flush out what exactly is happening there? Are there a lot of other nontraditional financial customers, right, that are getting picked up there? Does this create maybe a tougher -- also a tough comp for next year? Or what keeps you, I guess, excited that there's more to go there, probably an area that doesn't get a lot of attention because people just think it's very recurring, but it has seen some swings?

It does. And I think it's important when people think about the fixed base that there is bank and nonbank, and we rate nonbank. When you think about captives, lease companies, BDCs, they are companies that I would distinguish away from your traditional bank. And the bank issuance has been also robust because there's a need to meet capital buffers and provide for the prospect of loan losses. So you've got 2 sides of that business, and it's important to keep that in mind.

Okay. Great. Then switching gears a little bit away from issuance. You mentioned China yourself. You know very much that I'm very focused on that opportunity given the size of the market. You mentioned in your slides a little bit that you like your position there. I guess the question I would have, it sounds to me like you like the position you have with CCXI, if an opportunity arises, to maybe on a bigger chunk of this, you probably would jump on it, not to put words in your mouth. Just talk to me about how that would work. Let's say, you really would own this business in the future, is there -- given that, clearly, the opening up of the Chinese markets wants some -- a different model to some degree, right? It's a market, as we all know, that is very much highly rated today. And all these reforms they're putting into place are really about attracting more foreign capital, and they want maybe a better representation of what the market -- what the risk is in some of these businesses. So long-winded question of [ SNIC ], did you feel that CCXI, if Moody's was a bigger stakeholder, could kind of shift their business around to kind of become a little bit more westernized, if that's the right word?

Well, I'll try and put an answer together on that, Alex. And I think it's a -- first of all, it's a complex situation and one where, first and foremost, we want to participate in, in the opening and development of the Chinese capital debt market. And where we are at this moment, we -- as you rightly say, we are comfortable. We believe we have optionality with the current position that we have. But then I would take it up to the next level and think about that broader functioning of a debt capital market as it comes to debt. And therefore, what you need to ensure is that there's the full spectrum of credit risk that investors have an appreciation for, and they can differentiate between different levels on the rating scale. And it's also important that there are defaults, what causes defaults and build up that trend analysis as that occurs. And therefore, providing rating scales, providing data, providing research and broader engagement, not only into debt investors, but across the authorities in the markets is something that Moody's believes it can do. And I think that position that we have at the moment allows us to do that. We've also got other tools and services coming from Moody's Analytics that can bring even further transparency into the market with regard to furthering data and access to tools. So there's much, much more to go with our thoughts on China, but we feel it's going in the right direction.

Okay. Great. I think -- I see we're running out of time, so I'll ask you one more question. And this is on the other side of the income statement, which is more a CFO question. But clearly, this has been a very profitable business. I guess I'm curious how much you are focused on the cost side of the equation, if you are, and what opportunities still exist to make that business even better. And you talk about technology a lot, so it would be great to see where you are in that journey.

Yes. I think we're pretty pleased with regard to the discipline that we have over our expense management because that is what continues to create the operating leverage. And we will always continue to evolve our overall approaches, whether it's adapting our meeting formats to virtual rather than in person. Naturally, that will result in T&E savings and marketing savings. But at the end of the day, we have to meet the needs of our customers. So that will be somewhat more moving as we get back out of the COVID situation. We also continue, like any good operation here, to reduce expenses through procurement activities, lower-cost locations. And we've also taken a number of restructuring actions that resulted in $60 million of run rate savings this year. That's in addition to prior restructuring programs that we've had in place, so we feel that we've got a good set of tools in our kit. And then there's the focus that we will continue on our real estate and making sure that we are efficient to ensure that we deliver for our employees around the real estate but also ensure that we deliver for our customers. So feel good where we are. And first and foremost, we want to ensure that we're reinvesting well in our business to shore it up for a very strong future.

All right. Great. I see that we are a minute over time, so we better wrap it up. Thanks for that. I could probably talk for many more minutes, but thanks for participating and having a great day at the conference today. So thanks again, Michael, and hope to do this in person soon.

Thanks, Alex, and thanks to everybody at UBS for what has been a great day.